European Energy Firms Seek to Escape Tougher Regulation

European power and gas traders fear that a raft of new regulations thought up after the credit crisis and gradually applying to their sector could raise compliance costs and hamper liquidity by putting off new entrants into the market.

Their concerns focus on the future definition of forward contracts and of traders' hedging activities, as well as risk and equity capital requirements under the Markets in Financial Instruments Directive (MiFID) and other incoming regulation.

"Should some of the current proposals on the table be finalised in that shape and form for 2017, power trading could dry up," said Barbara Lempp, managing director of the German arm of European energy traders' lobby EFET.

Since deregulation began to take effect in European wholesale power trading 15 years ago, experts say the market has reached an annual value approaching 1 trillion euros ($1.1 trillion), a size that regulators think creates worrying risks.

However, that is a tiny fraction of a global derivatives market worth 471 trillion euros, according to Deutsche Boerse data.

A spokesman for the Paris-based European Securities and Markets Authority (ESMA) said if a commodity firm behaves like an investment firm it should be regulated as one, but sector specifics could be taken into account.

"ESMA's aim is to find a good, solid and fair solution to differentiate between financial trading and trading with a physical background, achieving the right balance between greater market transparency and safety whilst appreciating business interests," he said.

Traders say that under new rules, forwards contracts, used by utilities to cover generation risks and lock in fuel input prices, could be treated as financial instruments that require banking licences.

"The costs incurred by energy trading companies would continue to rise (in that case)," said Maik Neubauer, a partner at the Executive Partners Group, a Hamburg-based consultancy.

Draft proposals from ESMA have also suggested capturing by MiFID those trading activities that exceed 5 percent of the capital employed for a company's overall activities, where presently 50 percent is allowed.

ESMA may put a limit of 0.5 percent on the market share traders in the European Union can have in any given commodity, although traders say such a cap can easily be exceeded by the trading desks of many German local utilities.

Energy companies have already tightened their belts in recent years as profits fell due to low wholesale energy prices, so added costs at this stage would be another burden.

"The question arises, 'can I earn adequate interest on the capital I have to tie up there, or will the costs be so high that I am forced to leave the markets'," said Stefan Dohler, head of markets at utility Vattenfall.

"The risk is high that the market will function less well than it did before," Dohler said, pointing to what he called "high entry fees" into the market if ESMA proposals go through as they stand.

Utilities and energy trading companies will need more manpower and technology to comply with the transparency rules.

Services firms may gain from the regulatory changes as they offer systems and software to monitor trading and aid compliance. Such companies include Deutsche Boerse's Market Data and Services unit; b-next, which provides trading surveillance; and platform provider Trayport.

By Vera Eckert and Nina Chestney